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Thursday, October 2, 2008

Markets Efficient?

One of the criticisms we constantly hear of Graham and Dodd's Security Analysis is that it's too old and it no longer applies. Information is too readily available nowadays, critics say, and therefore inefficiencies no longer exist. We disagree. As examples, we've discussed here some very recent inefficiencies that offered great profits for investors. We've also discussed the stories of some very successful current value investors, and how they've been successful.

Graham and Dodd also discussed inefficiencies not just at the individual stock level, but at the market level in aggregate. At times, stocks were extremely fashionable, causing companies to continually issue shares to cash in on this phenomenon. At other times, depending on the economic climate, deserving companies were not able to raise a dime. We see a table below where Graham and Dodd demonstrated back in the 20s and 30s that these gyrations in stock issues from year to year exist.

Below, we look at a modern-day cross-section of this data. Shown is a chart listing IPO issues and their aggregate dollar amounts since 1970. In an efficient market, we would expect these to be smooth from year to year, after all, why should people be willing to pay more one year but not the next? However, we clearly see that during bear markets (e.g. 1972-1974, early 1990s, early 2000s etc.), companies don't issue, as they don't feel they're getting enough in return for the stake they're selling in their companies. On the other hand, during bull markets we see a great number of companies trying to sell their stock for perhaps more than it is worth, as a speculator and his money are soon parted.